Yen's Kamikaze Flight Trajectory

Forget about the flight to the dollar at the peak of the financial crisis:
the yen was the ultimate beneficiary. The endlessly quoted unwinding of the
carry trade was a factor, but there may have been a more important force at
play. As that force may now be under increased pressure, the yen may be in
trouble. The force we are talking about is the free market.

How can market forces drive up the yen when Japan has been a leader in quantitative
easing, the "art" of printing money? Japan epitomizes the battle between market
and government forces. Left to its own powers, Japan's economy would have imploded
after its asset bubble burst in 1990. While painful, the good news about a
deflationary collapse is that you can rebuild; a collapse is also a brutal
way of weeding out those with too much debt. Instead, the government has, to
varying degrees, been fighting market forces ever since. However, as of late,
the Japanese have relaxed their attack on free market dynamics, in large part
as a result of weak leadership.

Fighting market forces can be extremely expensive: if market forces ultimately
win - i.e. the collapse ultimately happens - it's possible for a country to
destroy its currency along the way. Left to market forces, those with debt
likely go broke. Left to policy makers, everyone may eventually go broke.

The yen started strengthening in the summer of 2007. In September '07, the
prime minister at the time, Shinzo Abe, resigned after months of mounting political
pressure. Abe had succeeded the very charismatic Koizumi, who was featured
in various advertising campaigns throughout the U.S. promoting Japan. There
have been three more prime ministers since Abe; there have been six finance
ministers in Japan since August of 2008. With such a dysfunctional government,
the government did not spend extraordinary amounts, nor did the government
interfere much with the Bank of Japan. Indeed, it seems almost ironic that
the Bank of Japan, historically prolific quantitative easers, was conspicuously
absent when the most recent round of global "quantitative easing contagion" infected
central banks around the world. Left to market forces, consumers preferred
to save, bolstering the yen.

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In that context, the conventional wisdom that a country needs to have economic
growth to have a strong currency is, in our assessment, wrong. Such a relationship
only applies to countries that depend on foreigners to finance their deficits.
In the U.S., foreigners finance the twin
deficits; one of the reasons why the U.S. has economic growth as a top
priority is to entice foreigners to keep financing U.S. deficits. Australia
also has a current
account deficit and, as a result, has a currency that is sensitive to economic
growth prospects. Japan, however, traditionally finances its deficits domestically;
as a result, the value of the yen is not very sensitive to changes in growth
forecasts. The same can be said for the euro zone: because the euro zone does
not have a significant current account deficit, in our assessment, the euro
can do well in the absence of economic growth.

Another way to think about it is as follows: Fed Chairman Bernanke has repeatedly
emphasized how going off the gold standard during the 1930s allowed the U.S.
to recover from the Great Depression. In plain English: if you devalue your
currency, take away the purchasing power of the people, you provide an incentive
for top line economic growth. On the other hand, if you don't pursue a policy
to intentionally weaken your currency, you may end up with lousy economic growth
on the backdrop of a much stronger currency. Japan and the euro zone are prime
candidates for that.

Except that the story may not have a happy ending in Japan. Japan's ability
to finance its deficit domestically is limited and may run out in the coming
years. At that point, Japan's currency may be crushed given the weight of government
debt. But rather than pondering about the end game, we are concerned about
the years leading up to that point.

In September 2009, the then opposition Democratic Party of Japan (DPJ) swept
to victory, unseating the previous government that had been in power with barely
any interruption since 1955. DPJ's success was to a great extent a reflection
of the failure of the previous government; their party manifest was about cutting "wasteful" spending,
but then turning around to spend it on the "right" priorities. Known for fiscal
conservatism and a hands-off approach to the Bank of Japan, 77-year-old Hirohisa
Fujii was appointed Minister of Finance. In early January, Fujii resigned due
to health reasons; when his successor, Naoto Kan, was appointed, we announced
the yen had lost its status as a hard currency. What happened?

Aside from a couple of Japan-specific issues, such as shifting power from
bureaucrats to politicians, the new government has struggled to find its course.
As the realities of governing are setting in, the appointment of Kan as finance
minister was the trigger for us to suggest that the DPJ has gained focus. That
focus suggests boosting economic growth through greater fiscal spending, a
more interventionist approach to managing the private sector; and greater meddling
with central bank policy to boost economic growth. And, no, the Japanese are
not copying the U.S.; Japan is a leader in fiscal spending and quantitative
easing; Japan had merely taken its eyes off the ball in the past two and a
half years. The focus is back on now - the yen may have been placed on a Kamikaze
mission.

We are not suggesting the yen will fall off a cliff tomorrow. Indeed, the
yen's risk-return profile may provide valuable diversification benefits to
select portfolios. However, we have stripped the yen of its hard currency status
- a status the yen had only earned during the run-up to the financial crisis.
As a result, we have eliminated the yen not only from the Merk Hard Currency
Fund (MERKX), but also from
the Merk Asian Currency Fund (MEAFX).
For the Merk Absolute Return Currency Fund (MABFX)
that seeks absolute returns by investing in currencies, the investment process
is foremost driven by a quantitative model, supplemented by a risk and macro
overlay; MABFX currently has neither a long, nor a short position in the yen.
Currency exposures are subject to change without notice.

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard
money, macro trends and international investing. He is considered an authority
on currencies.

The Merk Absolute Return Currency Fund seeks to generate positive absolute
returns by investing in currencies. The Fund is a pure-play on currencies,
aiming to profit regardless of the direction of the U.S. dollar or traditional
asset classes.

The Merk Asian Currency Fund seeks to profit from a rise in Asian currencies
versus the U.S. dollar. The Fund typically invests in a basket of Asian currencies
that may include, but are not limited to, the currencies of China, Hong Kong,
Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea,
Taiwan and Thailand.

The Funds may be appropriate for you if you are pursuing a long-term goal
with a currency component to your portfolio; are willing to tolerate the risks
associated with investments in foreign currencies; or are looking for a way
to potentially mitigate downside risk in or profit from a secular bear market.
For more information on the Funds and to download a prospectus, please visit www.merkfunds.com.

Investors should consider the investment objectives, risks and charges
and expenses of the Merk Funds carefully before investing. This and other
information is in the prospectus, a copy of which may be obtained by visiting
the Funds' website at www.merkfunds.com or calling 866-MERK FUND. Please
read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in
currency exchange rates will affect the value of what the Funds own and the
price of the Funds' shares. Investing in foreign instruments bears a greater
risk than investing in domestic instruments for reasons such as volatility
of currency exchange rates and, in some cases, limited geographic focus,
political and economic instability, and relatively illiquid markets. The
Funds are subject to interest rate risk which is the risk that debt securities
in the Funds' portfolio will decline in value because of increases in market
interest rates. The Funds may also invest in derivative securities which
can be volatile and involve various types and degrees of risk. As a non-diversified
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and potential for volatility than a diversified fund because its portfolio
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This report was prepared by Merk
Investments LLC, and reflects the current opinion of the authors. It
is based upon sources and data believed to be accurate and reliable. Merk
Investments LLC makes no representation regarding the advisability of investing
in the products herein. Opinions and forward-looking statements expressed
are subject to change without notice. This information does not constitute
investment advice and is not intended as an endorsement of any specific investment.
The information contained herein is general in nature and is provided solely
for educational and informational purposes. The information provided does
not constitute legal, financial or tax advice. You should obtain advice specific
to your circumstances from your own legal, financial and tax advisors. As
with any investment, past performance is no guarantee of future performance.